Should you stake your pension on house prices? Property funds tempt investors, but experts warn of risks

Taking a punt on property prices with your retirement savings is apparently considered a good idea by almost two in three IFAs, but pension providers have warned investors off it for now.

A recent flurry of start-up investment products which rise and fall with national or localised property prices has been met with scepticism from industry experts who have sincere reservations about the risk involved given the current state of the UK housing market.

Research commissioned by Castle Trust, which in October launched its HouSA investment products which track the Halifax house price index, claims that 63 per cent of financial advisers believe access to UK residential property investment would help investors with pension planning.

Housing gamble: Industry experts are skeptical that resident property funds will provide a decent return given the current state of the housing market.

Savers cannot invest directly in residential property through their pension. However, they can use Self-Invested Personal Pensions (Sipps) to invest in qualifying residential property funds, thereby gaining tax relief, but while they will see an increase in value should house prices rise, they will similar lose a chunk of their investment should they fall. They may also be able to put them in an investment Isa.

Sean Oldfield, chief executive of the Castle Trust, thinks investing in such products could be more attractive to savers than going down the route of buy-to-let, with 42 per cent of survey respondents saying the high deposits needed for buy-to-lets is a barrier for them investing in bricks and mortar.

He said: 'Financial advisers recognise the value of
UK residential property as a valuable diversifier in a portfolio, but
are concerned about having to invest in bricks and mortar to do so.

'House prices and household incomes
are inherently linked over the long term making housing ideal for
pension portfolios that need to keep pace with wage inflation.'

Although the research indicates a good portion of IFAs say access to residential property investment would assist pension planning, Mike Carpenter, director at independent IFA Carpenter Rees, says they would be unlikely to recommend such an investment.

He said: 'While we have seen property as an investment for clients – both in
terms of their owner occupation and also rental yield – it’s unlikely
that we would recommend residential property funds at this stage in the
economic cycle.

'Property is all about location, whether for buy-to-letting or for home ownership. Very few reasonably priced properties are
coming onto the market and our concern is that the current stock
available for sale is not of the highest quality.'

'In the short term,
this type of investment might lead to yields at reasonable levels – as
much as 7.5 per cent in some areas, before any sort of fund charges.

However, fund costs, and the illiquidity aspects of property, make this
type of investment a concern.'

The residential property funds on offer

Castle Trust offers one of a handful of residential property investment products which have launched this year, these aim to track the Halifax house price index with either income or growth options. Castle Trust claims: 'Your investment will outperform UK house prices over the term you choose, whether they rise or fall.'

The TM Hearthstone UK Residential Property Fund from Hearthstone Investments aims to grow people's funds by matching the average increase in UK house prices, after it invests in privately rented homes.

London Central Portfolio, runs a series of funds hoping to achieve handsome returns for investors by focusing on the evergreen prime central London market. It buys properties which are then let to high-end tenants, with returns delivered by any rise in property values over a set period. It recently closed its third fund to new subscriptions.

Castle Trust property fund: Positives and negatives

Positives:

You don't need a big deposit to invest in property, with investment starting from £1,000.

Tax-free returns as investment made through Isas or Sipps.

Avoids the hassle of managing your own buy-to-let property.

Potentially decent return if house prices rise.

Negatives:

Potential to lose portion of investment should Halifax index shows a price fall, or lose out on growth elsewhere if they remain stagnant.

No sign yet of housing market recovery.

Charge of 3% on investment, commission paid to IFAs.

Buy-to-let can provide decent rental income and potentially big bump in value through home improvements.

But investors should think twice before pumping their savings into residential funds, according to Danny Cox, head of advice at Isa and Sipps provider Hargreaves Lansdown, as outside of London and the South East, there is little sign of a property boom in the short-term.

Halifax, in its monthly house price index for November, said that there had been five monthly rises and six falls this year, and predicted that house values will remain within a margin of between plus and minus two per cent during 2013.

Mr Cox said: 'There are limited occasions where
property is a good investment for pension and these generally only apply
to business people whose business property is owned by their Sipp.

'I think you have to seriously question
why anyone would want to buy residential property as an investment in
the current economic climate, whether in pension otherwise.

'There will
be exceptions, however, property values are more likely to track
sideways than increase in value over the next few years, with the
exception of areas of London and the South East, all of which trade for a
premium.

'A combination of negative wage growth, short supply of mortgage credit,
lack of confidence in the employment market all add up to poor market
conditions. A long term investor may do well.

'Property is one of the most expensive ways to invest and highly
illiquid. Liquidity in pension investments is very important as people
approach retirement.'

How Castle Trust invests in house prices

Castle Trust, which uses investments to offer partnership mortgages, offers a Growth HouSA and an Income HouSA for investments of between £1,000 and £1 million through Isas, junior Isas and Sipps for fixed terms of three, five and 10 years.

The Growth HouSa offers a gain of 1.25 or 1.7 times the Halifax index over the term, or a loss of between 0.75 and 0.3 times the decline.

The Income HouSA meanwhile tracks the Halifax index, while providing a yearly payout of 2 or 3 per cent your investment.

Castle Trust charges a 3 per cent fee upon investing, so putting £1,000 in would see only £970 invested, and it also pays commission on products sold via IFAs.

Using the Halifax pricing index since 1983, Castle Trust says the highest house price rise during this time would have seen a £1,000 investment return £1,794.50 over a three-year fixed term, with the average return would have been £1,251.30.

However, the lowest return over three years would have been £853.60, a loss of £146.40.

Do it yourself: Improving a run-down buy-to-let property could reap much greater rewards in the long-run than a residential property fund.

In its brochure, it argues that with the investment spread over the entire housing market, it mitigates the risk of local conditions which may negatively affect the value of an individual property.

It also avoids the Capital Gains Tax you would otherwise incur when you sell a property at a profit, as pensions and Isa investments are not taxed.

But investors in buy-to-lets can enjoy the hefty increases in value caused by growths in localised demand as well as increasing a property's value by improving it, particularly if it was run-down to begin with.

Mick Gilligan, head of research at bonds, Sipps and Isa provider Killick & Co, thinks investors already have enough of their money tied up in residential property.

He said: 'Most private investors already have a large portion of their net worth exposed to residential property. This is typically in a leveraged form as a result of mortgage financing.

'Given this, a residential property fund is unlikely to be an optimal addition to most investors' portfolios from a diversification perspective.'